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How much should markets fear a Greek default?

Greece’s Prime Minister, Alexis Tsipras, is facing an unwinnable game writes Alan Cauberghs. Having ordered a €750 million loan payment to the IMF in May, just hours ahead of crunch talks with Greece’s creditors, the country remains far from out of the woods. The next IMF deadline is this Friday (5th June), when a €300 million loan repayment is due. In May, some members of Mr Tsipras’ governing Syriza party had lobbied for defiance of the payment. What remains clear is that Mr Tsipras can either appease the country’s creditors or his electorate. Not both.

Without further assistance, Greece could default on its debt repayments as soon as this week. But how significant an event would a default be for investors? It is important to note that it is far from certain that a default on its IMF payment would lead to Greece’s exit from the eurozone and consequently a default on its European lenders.

Greece’s links with the eurozone financial system have significantly declined in the wake of 2012, when one of the largest debt restructuring deals in history wiped €100 billion from Greece’s liabilities. The risks associated with Greek sovereign debt also largely passed from the eurozone’s banking sector to the eurozone’s public sector.

The bulk of Greek debt is held by the European Financial Stability Facility (EFSF), the European Central Bank (ECB), and the European Investment Bank (EIB) as well as some in bilateral loans. The bilateral loans, according to S&P, amount to €53 billion, so their importance should not be downplayed. However, in October 2014, the degree of direct exposure to Greek debt by eurozone governments stood at €302 billion. This amounts to around 3% of eurozone GDP (excluding Greece), and we believe that the direct impact of a Greek default should be limited.

From the EFSF perspective, the net balance sheet exposure to Greek bonds is around €166 billion, but this will be absorbed by the eurozone member states over a number of decades. The restructuring process also extended the repayment schedules for the Greek bonds in question. The first repayment to the EFSF is due in only 2023. It is also important to note that the central banks of most eurozone member states would not need to cover capital short falls as a commercial bank would.

The ECB’s exposure is predominantly via the Emergency Liquidity Assistance (ELA) scheme, which allows Greek banks access to the additional liquidity so long as they can provide enough eligible collateral. Were Greece to default on a bond payment, the ECB would be able to withdraw this support, and any shortfall, as detailed above, would not necessarily need to be covered.
The EIB exposure amounts to around €7 billion. In relative terms, this is a small sum for the EIB and we envisage no risk of the bank becoming insolvent. On its own, it would not destabilise the bank.

Finally, the contagion risk for Greek debt has also been theoretically muted by the establishment of the European Stability Mechanism. This pot of capital, of around €500 billion, should maintain the flow of cash for affected states should there be any threat to vital payments brought on by a Greek default. Of course, the possibility of hidden financial ties, as well as indirect and political implications, must not be ruled out. If Greece outright and unilaterally defaults, it is likely to have significant market implications at least in the short run. However, we believe that structurally, global financial markets look well shielded from the fallout of such an event.”

Alan Cauberghs, Senior Investment Director, Fixed Income. Schroders

  1. EU and IMF want Greece to default and Syriza government to fall. Greece will be allowed a write-off only under government like by EU and IMF.

    Comment by Jože Vogrinc on June 11, 2015 at 9:02 am
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